Policy rate cut by 150bps to 10.5 percent: private sector credit woes, improved inflation outlook

Taking into account two major developments that inflation outlook has improved for FY13 and loans to private sector have drastically decreased, the State Bank of Pakistan on Friday lowered its policy rate by 150 basis points to 10.5 percent with effect from August 13, 2012. An announcement to this effect was made by Governor SBP Yaseen Anwar, after the meeting of Central Board of Directors which took place earlier in the day.
Utilisation of credit by private businesses is one of the important ingredients of investment. The net flow of credit to private sector was Rs 18.3 billion in FY12, which is a drastic decline compared to a net flow of Rs 173.2 billion in FY11. "Not only the amount disbursed to private sector was small but retirements from them was unusually high." A disaggregated assessment shows that large part of total credit extended to the private sector was in fact avoided by non-bank finance companies, according to the SBP data. Inflation outlook has improved and SBP projects it at 10.5 percent for FY13. Loans to private sector businesses have sharply declined. This led to an increase in real interest rates.
SBP expects a fall in international price of oil due to slowdown of economies of OECD countries and the BRICS nations. The former economic advisor to the government, Sahab Sherani, told Aaj News that 150bps cut would not generate investment from the private sector because of structural facts - such as fiscal weaknesses (falling revenue and increasing expenditures); electricity and gas shortages; mismanaged/bleeding public sector; and poorly educated and unskilled workforce. He reinforced his argument by stating that the maximum length of time Pakistan growth episodes have never lasted more than four years.
"The Central Board of Directors of SBP has decided to give a relatively higher weight to the state of private sector credit and investment in the economy, knowing that the projected inflation for FY13 could remain slightly higher than the target," said Governor SBP Yaseen Anwar while addressing the press conference. However, he said, improvement in key economic indicators would require comprehensive and credible reforms in the energy and fiscal sectors. Adherence to the legal frameworks of economic policy making is important as well.
"A drive for economic reform and adherence to laws can go a long way in moving the economy towards a better equilibrium with low and stable inflation and high and sustainable growth," he added. Growth in real GDP for FY13 to remain between 3 and 4 percent; well below the target for the year and country''s economic potential, he said and added that in order to revive economic growth, the focus must be on an endogenous reform process that focuses on improving infrastructure, productivity, and governance.
Talking about the fiscal deficit, the governor said that given the domestic energy crisis and deteriorating global economic conditions, the trade deficit for FY13 is not expected to be significantly different from FY12. However, the recent receipt of $1.12 billion in Coalition Support Funds and the expected receipt of much delayed auction proceeds of 3G licences could reduce the external current account deficit to $2.5 billion in FY13.
"The real focus would need to be on the prospects of financial inflows so that the economy can build foreign exchange reserves to meet the rising debt obligations in the next few years," he urged. The contraction in private investment, for the fourth consecutive year, at 13 percent is particularly of concern, he said, adding that the total investment, as a percentage of GDP, has fallen to 12.5 percent in FY12, which does not bode well for the future productive capacity of the economy.
Anwar said that the utilisation of credit by private businesses is one of the important ingredients of investment. "Given the desired expansion in the private sector credit and the growing need of the public sector to borrow from the banking system, a consistent increase in deposits and improvement in overall financial depth is imperative," he emphasised.
In this constrained environment the impact of monetary policy has become limited. However, he said that State Bank will continue to play its required role in nudging the macroeconomic outcomes whenever there is a relative ease in some of its core concerns.
Some deceleration in inflation, which has improved its outlook and the receipt of much delayed Coalition Support Fund has eased, on the margin, the fiscal and external sector constraints, he added.
SBP Governor said the fiscal borrowings from the scheduled banks grew by 50 percent in FY12 and contributed 67 percent to the overall increase of 14.1 percent in M2. ''Apart from crowding out the private sector, these substantial and, at times, unpredictable fiscal borrowings created substantial challenges for monetary management,'' he added.
He said that given a retirement of Rs 198 billion during the first month of FY13, it seems that the fiscal authority is beginning to make efforts to reduce its borrowings from SBP. ''This was made possible due to considerably higher borrowings from the market in the two T-bill auctions in July 2012, he said.
He added: "it should be clear that a prudent approach in consistently implementing the requirements of the SBP Act, without adverse implications for the economy in terms of excessive borrowings from the scheduled banks, would require a consistent decline in the fiscal deficit through comprehensive fiscal reforms". SBP Governor emphasised that the real focus would need to be on the prospects of financial inflows so that the economy can build foreign exchange reserves to meet the rising debt obligations in the next few years.